#62. The integrity deficit

WHY TRUST IS AN ECONOMIC IMPERATIVE

Surprising though it may seem, there are people who really believe that they take nothing on trust, accept nothing without proof, and ascertain all the facts before doing anything. This belief is, of course, nonsense, and our everyday lives would be impossible without trust.

The same is true of our everyday economic lives, which also depend on trust. It simply isn’t possible to operate an economy effectively without a very great deal of trust.

Though what has happened at Volkswagen is extreme, it does provide a useful reminder of the importance of trust in how the economy functions. This issue needs to be considered because, unfortunately, policymaking has, for far too long, been dominated by economic thinking which fails to take account of the critical importance of trust.

The ideology which asserts that the market economy is a sort of free-for-all – in which caveat emptor (“buyer beware”) over-rides the need for integrity – has created a dangerous deficit in trust.

Ultimately, this deficit could be more critical than the familiar trade and fiscal shortfalls with which economies continue to grapple.

To this end, this article looks at why trust is so important to the economy, and at why the apparent undermining of trust may be a very serious economic negative. Of course, there is a limit to what we can cover here, but there can be no doubt that the issue of trust is critical. When the current “anything goes” economic orthodoxy is overthrown – which is surely only a matter of time – whatever replaces it must rediscover the critical role of trust.

Why trust matters

Trust in others is so integral to our everyday lives that few of us ever question it.
When someone hands you a cup of coffee, you don’t test it for toxins. When you get in a cab, or someone offers you a lift, you don’t demand to see the vehicle’s roadworthiness certificate. When you get on a bus or a train, you don’t insist on seeing the driver’s licence, or testing him for alcohol. When you see a doctor, you don’t demand proof of his credentials. And so on.

Trying to check such everyday things would make life quite impossible. The sheer bulk of the test equipment you’d have to carry around with you is just the first of the problems you’d encounter. How are you to be sure that the suppliers of this test equipment are themselves trustworthy? When the bus driver shows you his driving licence, how are you to check that it was obtained legitimately?

The reality is that we have no choice but to exercise trust on numerous occasions in our everyday lives. It cannot, realistically, ever be otherwise.

The same is true of our “economic lives”. When a utility sends you a bill based on your consumption of electricity, gas, water or phone-time, you really have no choice but to take their word for it. Homes are metered, of course, and checking the meter reading can be a good idea, but the meter is likely to have been provided by the same supplier from whom you purchase your gas or electricity.

The quickest of reflections will convince you of the sheer extent to which trust is required in economic transactions. Virtually any purchase of goods or services requires trust in the supplier, as does any venture into investment, or any use of financial services.

Trust and economics

Economic trust is so fundamental that it should be incorporated into any understanding of the economy. Unfortunately, conduct of the world economy has, for three decades or so, been dominated by a school of thinking which fails to make this vital connection.

This school of thought – variously labelled “the Anglo-American economic model”, “the Washington consensus” and “neoliberalism” – asserts, instead, that the free market economy operates along “law-of-the-jungle” lines. Customer self-interest is seen as self-sufficient, making trust less relevant.

This thinking is utter nonsense, but this has not prevented it from gaining massive influence over how economic affairs are conducted.

Where economics and trust are concerned, what are the fundamentals? Well, wherever you stand on the spectrum, you would struggle to deny that competition is the most important discovery that we have ever made about the economy.

It is, incidentally, for his emphasis on competition, and not for a supposedly-doctrinaire preference for the private sector over the state, that Adam Smith is rightly venerated.

The theory of competition is straightforward. Multiple suppliers seek the customer’s business. To get it, each strives to offer a better price than the others, or better quality, or a combination of the two. This process drives innovation, and best value for customers, and in these ways promotes the general betterment of the economy.

This theory is by no means confined to competing suppliers of brooms or vacuum cleaners, and the benefits of competition stretch far beyond the consumer. Workers benefit where potential employers compete for their skills. Savers benefit where businesses compete to offer the best returns on investment. Society, and the economy as a whole, benefit because competition stimulates striving and innovation.

Adam Smith was at his most emphatic when he condemned the threat posed to competition by cartels and monopolies, and there are many often-quoted Smith remarks about the evils of concentration, something which Smith condemns as being, everywhere and always, aimed at duping the customer by rigging the market.

Incidentally, Smith’s strictures against monopoly are often wilfully misrepresented as opposition to the state and a preference for private ownership. This is nonsense, both historically and logically.

Historically, it is nonsense because there were no nationalised industries in Smith’s day, when a minimalist state provided little more than basic government, a legal framework and national defence. There wasn’t even a state-funded police force in Smith’s era, let alone state provision of health care, or involvement in industry – so there wasn’t a “public sector” for Smith to be opposed to. Moreover, his condemnation of cartels and monopolies was specifically addressed at private-sector market abuse.

Essentially, the market theory associated with Smith demonstrates that monopolies and cartels are bad for the economy, irrespective of whether they are private- or state-owned.

What is equally clear is that markets cannot operate effectively if participants lie or cheat.

The whole theory of markets is that buyers choose from a range of alternatives, and this in turn absolutely requires that the purchaser knows what these alternatives are. If one or more potential suppliers lie about their products, the ability to exercise an effective choice is undermined, and potentially lost altogether.

The essential preconditions

From the competitive theory associated with Smith – and ignoring the endeavours of those who wish to co-opt him on one side or another of today’s debate – we can arrive at certain necessary foundations for the successful economy.

First, we can state that unfettered competition is imperative, and that any departure from it weakens the economy.

Second, we can assert that any monopoly or cartel, irrespective of who owns it, is bad for the economy.

Third, and arising from this, there must be a regulatory power that prevents excessive concentration. Left to themselves, stronger players would drive out weaker ones, either by acquiring them, or by using pricing power to drive them out of business.

So regulation, and by extension the state as guarantor of competition, is an implicit part of competitive economic theory. The role of the regulating power, through the prevention of concentration, is in fact that of “saving capitalism from itself”.

Fourth, we can assert that trust is an absolute requirement for an effective economy. Competition relies on freely-exercised choice, and this cannot happen where market participants lie or cheat.

Doctrines of distortion

All of this is a very far cry from the extreme neoliberal doctrines that endeavour to disguise themselves in Adam Smith’s clothing. These ideologies seek to persuade us that “all’s fair in love, war and the market-place”, and also assert that private ownership is the best solution to each and every issue.

In so doing, they necessarily understate the dangers of concentration, and of the abuse of market power. They paint the state as the antithesis of the free market, rather than as the essential guarantor of efficient markets. Such thinking also tends to understate the role of trust, and this may be its greatest single weakness.

The neoliberal extreme isn’t, even remotely, a truly market-capitalist analysis, of course. For a start, the free market isn’t anarchy, and doesn’t operate along “law-of-the-jungle” lines. If it did, smaller competitors would be destroyed, which would reduce or eliminate competition. Regulation, as we have seen, is an indispensible part of the effective market.

Equally, honest dealing is imperative, for which caveat emptor is no substitute. Given the practical impossibility of customers checking everything for themselves, it is absolutely essential that market participants are honest and truthful, enabling trust to be exercised. If it is imperative that suppliers tell the truth about the goods and services that they offer, it is equally imperative that information presented to investors is true and fair.

As well as guarding against concentration, the state has a critical role to play in underpinning market integrity. We should applaud the largely unsung heroes of the consumer protection profession, and welcome the recent tightening of UK consumer legislation. I have been delighted to see the EU throwing a spoke in the wheels of corporations that want to ship our data across the Atlantic, and admire all of those who help us to block internet ads and disable tracking cookies.

But there are limits to how much any government agency, however diligent and however well-resourced, can do to protect market integrity.

So we still have to take a very great deal on trust

Is trust under attack?

This, of course, is where the Volkswagen test-rigging scandal is so important. Hoodwinking government agencies is pretty bad in itself, but the worst feature of this whole sorry saga is the way in which a hitherto-respected company has lied to millions of customers.

The prospective purchaser of a vehicle needs to know about emissions, and has no real choice but to accept what competing manufacturers tell him about this. Equally, the customer has no choice but to believe what manufacturers tell him about performance, fuel economy, safety and many other issues central to his choice.

It may be unlikely that what has happened at VW has occurred elsewhere in motor manufacturing – for one thing, it seems doubtful that other companies would have done anything quite so stupid, since it would surely be impossible to get away with something like this indefinitely.

Financial services seem to be the greatest single area of weakness in the structure of trust that is imperative to the effective functioning of the market economy. The sector’s integrity has been brought low by the sheer scale of the scandals that have been unearthed, from the rigging of Libor to the sale of payment protection insurance (PPI).

One reason for this lies in the relative lack of sophistication of customers – people who have a good understanding of how a car or a refrigerator functions may have far less ability to judge the quality or value of a financial product, and this opens up scope for abuse. Another factor seems to lie in a debasement of the industry culture along the lines of “buyer beware” and “law-of-the-jungle”.

But the breakdown of trust has by no means been confined to financial services. To cite just one example, utilities have been found guilty of duping customers, something to which the authorities, regrettably, tend to apply the comparatively-innocuous label “miss-selling”, when what has really happened is surely a form of fraud.

Another huge regulatory mistake, particularly in the banking sector, has been the preference for punishing the company (meaning its hapless shareholders) rather than the individuals actually responsible for the various scandals that have been unearthed. Fining shareholders is not much of a deterrent to executive dishonesty, and a combination of fines, imprisonment and asset-stripping would surely be far more effective.

It is strange – to say the least – that the authorities have failed to see how individual accountability is the appropriate deterrent to misbehaviour by individuals.

We should not for a moment believe that the breakdown of trust is unique to banking and financial services. Many businesses in the broader economy seem to have moved away from integrity, not least when they can use one-sided “terms and conditions” to cloak bad practice in literal legality.

It is surely obvious that, just because something is legal, that does not necessarily make it honest. I was reminded of this when, on a recent holiday, I was offered a “rotational enjoyment facility” (meaning a time-share) in a “new” and “exciting” resort that is actually both long-established and drab.

The trust deficit

Of course, economists recognise that the only real foundation for a country’s currency is “the full faith and credit” of the issuer – if trust in this is ever lost, a currency can rapidly cease to have any value at all.

Beyond this, however, one must question quite how seriously economists and strategists take the broader issue of trust. Properly considered, trust – and its operative counterpart, integrity – is essential to the effective functioning of markets, and observation strongly suggests that integrity has weakened to an extent that is far more dangerous than is yet widely recognised.

This seems to be a particular problem in countries that pride themselves on the “open-ness” of their economies and the extent of their commitment to “markets”.

Anyone who wants to see the current economic system reformed – rather than overthrown altogether – needs to demand a far greater emphasis on integrity. Though vital, there are limits to quite how much can be accomplished by regulation, legislation and sanctions.

The broader problem is cultural, and its solution may require a challenge to the logic of materialistic self-gratification. We need to rediscover the fundamental principle that, far from being a form of anarchy, markets need to be “free” and “fair” in ways that make honesty and integrity imperative.

The attitudes that we bring to our economic interaction are, of course, a dimension of our broader attitudes to society, a linkage that operates in both directions. Any philosophy founded on self-interest alone becomes more fatuous the more closely you examine it, as, surely, does any view of life which concentrates only on the materialistic.

A preference for trust over dishonesty is a view that any sensible person may hold.
But is a salutary reflection – and, I hope, an informative one – that an economy simply cannot be effective in the absence of trust and integrity.

In other words, if your instinct is to prefer a society in which trust and integrity are central, you may be pleased to discover that you have sound economic logic on your side.

Ultimately, a shortfall in integrity could prove to be the most dangerous deficit of the lot.

10 thoughts on “#62. The integrity deficit

  1. Thanks Tim for some thought-provoking ideas. There are echos here of Oliver James’ book on Selfish Capitalism which as he points out tends to be an Anglo-American phenomenon. However, your example, Volkswagen, is largely German – do you think that European business is being affected by the same process? I also wonder how much the decline of trust and honesty is due to the loss of christian influence which even in the absence of churchgoing seems to leave a pervasive imprint on the way Western societies function.

    • Thank you, David. I shall look out for that book, I’ve not read it but thought his “Affluenza” was excellent.

      Good point about VW. It is surprising that a German company is involved, though I gather that VW is an altogether strange outfit, very political and with lingering family interests, so perhaps not typical of Germany?

      I think the decline of Christianity is significant in this, because a religion – by encouraging people to think of things bigger than themselves – may impose limits on self-centeredness.

      But I also wonder about the role of advertising, which globally is a $500bn pro-consumerism propaganda machine.

  2. A worthy article, Tim!. The “full faith and credit” is all a nation now has to protect it’s status and its economy.

    This is where MMT is often criticised. Even though MMT describes what we actually have working today, it gets described as a free for all money spending spectre. One is always having to say we already can overspend even in the fanciful version of the economy of academic economists, but whichever system is believed it still has to actually manage the economy to not fall outside the full faith and credit limits. It therefore just ignorance sounding off but still effective with the uninformed public. It is damaging to the nation’s well being.

    • Thanks John

      There was a very good article in the UK’s Guardian newspaper recently, using MMT ideas in a fairly subtle way, pointing out that fiscal contraction in Britain must lead to either higher private sector borrowing or an overall contraction in credit (and looking also at the overseas flows component).

      Where I come at this – especially now, as I’m putting together my Surplus Energy model “SEEDS 16” – is that we have both a “real” and a “financial” economy to consider.

      Since 2000 (or arguably earlier), the US and the UK have seen big expansions in overall debt – private up to 2007, government borrowing after that, and, in the UK anyway, a policy of promoting more private borrowing going forward. Essentially, in the world as a whole, annual compound growth in debt since 2007 has been 5.3%, and arguably a lot more if you exclude inter-bank lending. This is much faster than growth in the economy. Logically, it cannot go on indefinitely.

      I plan to return to this soon, when I publish first projections from SEEDS 16.

  3. Great article Tim and very timely. I can’t help thinking that at the heart of this is an ethical problem. While we can’t ever hope to know the individual characteristics of a product when we buy something, it doesn’t take much to understand the structural nature of modern capitalism, which in many cases used indirect subsidies, on the environment, on labour or consumer trust when products and services are sold with incorrect or insufficient information to reduce prices and win the competition battle. Hence we sort of unconsciously collude with the system for our own benefit, often for the best reasons, but collectively this gives the power to the system to carry on as usual. So while I agree with your first point,”we can state that unfettered competition is imperative, and that any departure from it weakens the economy”, I believe this needs the qualification that completion must also be fair in that it does not gain unfair advantage through unethical placing of costs on people and the environment that have no power to resist, as after all the economy is ultimately a product of people and the environment.

    • Thank you. I think the ethical issue is critical, and – although I believe in the market economy – I think neoliberal ideas have undermined ethics. I hope I have demonstrated here that markets need to be “fair” (meaning ethical) as well as “free”.

      The environmental issue is indeed critical, in both senses of “environmental”. The obvious sense is climate change, which clearly is a cost that is not borne symetrically by those doing the damage. The other sense of “environment” is the global resource set, where our measurement of economic output excludes the economic rent attributable to the consumption of ultimately-finite resources.

      This is something that Surplus Energy Economics aims to address, and is something I expect to write about soon. In one sense, the climate change issue is part of the broader topic of finite resources and economic rent.

  4. Thanks for a very perceptive blog post.

    I’ve just finished reading Peter Hitchens “The War We Never Fought” about the so called “drug wars”. He talks about the decline of personal responsibility and the influence of 1960s libertarian culture and it occurred to me that this may be related to the point you are making. If you are right then the decline in trust in the economic sphere may be part of the wider social and political changes mentioned by Hitchens, in which case shifting this may be a somewhat bigger problem than it appears.

    • Thank you Bob. You have touched on something that fascinates me.

      If I had the time to do so, I would like to write a book about the period 1956-63, which I think was a short but utterly critical period in British history. Until ’56, Britain still saw itself as a world power – the country was still hard up after the cost of WW2, but retained ambitions on the global stage. Between ’56 and ’63, we were rocked, first, by Suez. This massive blow to confidence and prestige was followed by an unseemly pace of retreat from Empire, most of which was left to its fate, with little or no preparation, between ’57 and ’60. Mass immigration started in ’57. We abandoned all interests East of Suez, and MacMillan made his “great” (but I think claptrap) speech about “winds of change”. As if that was not enough, we had both Profumo and the spy betrayals. Not too long after this we scrapped TSR2, the new carrier CVA-01, and our missile programme, and retired our entire carrier fleet prematurely. Culturally a lot was changing too – “Look Back in Anger” comes to mind.

      I’m convinced that this ties in which what you, and Hitchens, refer to. It was almost as if, with being global “top dog” being no longer possible, and the establishment (typified by the old Etonian buffoon Eden) discredited, the UK withdrew into itself, which was essentially what both Polaris and “you’ve never had it so good” amounted to……

      As for the libertarian culture, Celia Haddon wrote a fascinating book about this, back in the ’70s I think, arguing that women were the main victims of the libertarian revolution – it is not surprising that Haddon attracted less notice than, say, Germaine Greer.

  5. One further comment – this very much reminds me of a book Peter Oborne wrote some time ago about the rise of political lying. His point was that prior to the Thatcher government if a minister was caught out lying he automatically resigned. Then things changed with a progressive loss in honesty over subsequent decades. The rot really started during the Major’s premiership (cash for questions etc.) and then got onto steroids during Blair’s labour administration. The point is that if our leaders cannot be trusted then the problem cascades through the civil service, public sector and, as you well describe, business and industry. Depressing.

    • Thank you, and it is indeed depressing. There seems to be any “anything goes” attitude, and the biggest loophole of the lot is the ability of politicians and officials to take on lucrative work after retiring or leaving public service.

      The attitudes of some UK businesses is depressing, too – they feel able to act however they like, so long as their “terms and conditions” cover it. I used to try to “buy British” – now I buy non-British, as Japanese, German and Spanish businesses seem far more ethical – a sad state of affairs, but I’ve been ripped off just once too often by British companies.

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